Introduction Global Economic Outlook, Q1 2016

In the first-quarter edition of Global Economic Outlook, our far-flung economists examine the global economic environment and offer their thoughts on the current situation and the likely future path.

As we head into the new year, there are factors that are bound to have a substantial impact on the path of the global economy. Among these are the decisions that will be made by the US Federal Reserve, the European Central Bank, the Bank of Japan, the People’s Bank of China, and the petroleum authorities of Saudi Arabia. Policy decisions by these and other governments, including those of the big emerging markets, will affect the path of exchange rates, commodity prices, inflation, and, ultimately, economic growth. For now, the world seems to be characterized by relatively strong growth in the United States, disappointing but improving growth in Europe and Japan, slowing growth in China, and weakness in many other emerging markets—the one big exception being India, where growth is actually quite impressive. The world is also characterized by very low inflation in the developed world, strengthening consumer spending in oil-importing countries, rising private sector debt in emerging countries, and weak business investment almost everywhere.

In the first-quarter edition of Global Economic Outlook, our far-flung economists examine the global economic environment and offer their thoughts on the current situation and the likely future path.

We begin with Alexander Boersch, who examines the Eurozone economy. Alex reports that, despite headwinds from emerging-market weakness and geopolitical tensions, the European economy has lately benefitted from strong tailwinds. These include lower energy prices, an aggressive monetary policy by the European Central Bank, a declining euro, and a neutral fiscal policy. The result is that Europe’s economy is on track for favorable growth in 2016. Growth is especially strong in Spain and Ireland and is picking up in Italy. Alexander notes, however, that risks remain for Europe, and that business investment is weak. He discusses various policy levers that might boost investment in the future.

Next, Patricia Buckley offers her thoughts on the US economy. She notes that the recent decision by the Federal Reserve to raise short-term interest rates for the first time in nearly a decade reflects growing confidence in the strength of the US economy. Although the United States faces headwinds from weak exports, itself the result of a strong dollar, Patricia points to a variety of mostly favorable influences driving better growth. These include historically low oil prices, continued strong job growth, the positive impact of a high-valued dollar on import prices, and pent-up demand for housing. She says that the US economy “has returned to a state of health that warrants a more normal monetary policy stance—which should be viewed as a positive.”

China is the subject of my contribution to the quarterly outlook, where I point to evidence that the slowdown in China’s growth has been getting worse. However, I note that, given the level of policy interest rates, the central bank actually has plenty of room to act in order to stimulate more growth. On the other hand, it might be reluctant to promote even more capital outflows from China. Rather, it may decide to engage in more fiscal stimulus. Meanwhile, the International Monetary Fund has granted China’s currency reserve status, setting the stage for more integration of China into the world’s financial system. I discuss what this action might imply for the future direction of the currency.

Next, Rumki Majumdar writes about the Indian economy. Rumki notes the relative strength of India’s economy, with fast growth and modest inflation. She says that consumer spending has led growth, but that it cannot be sustained going forward absent more investment and employment growth. She takes particular note of the external environment facing India’s economy, examining India’s trade with the rest of the world, including new trade agreements, as well as the environment for cross-border capital flows. She notes that inbound investment has been healthy, but that the trend toward less direct investment could be counterproductive.

In his article on Japan, Akrur Barua points to new data indicating that Japan did not experience a recession in 2015 after all. Yet he notes that consumer spending and business investment are “far from impressive.” Given the weakness of neighboring China, he concludes that, going forward, Japan will have to do more to boost domestic demand in order to keep growth at a favorable level. He concludes that this will require implementation of structural reforms, also known as the “third arrow of Abenomics.” He offers hope that completion of the Trans-Pacific Partnership will provide the impetus for the government to move on structural reforms.

In our next article, Ian Stewart notes the resilience of the domestic side of the British economy. He discusses all of the various headwinds that Britain’s export sector faces and concludes that domestic demand will be key going forward. This seems likely given “a combination of falling unemployment, rising real wages, low inflation, and cheap credit.” On the other hand, the corporate sector has been hit by reduced willingness to invest, largely because of concerns about the external environment. Finally, Ian discusses the hot political topic of the upcoming referendum on UK membership in the European Union. He notes the uncertainty about the outcome stemming from troubles in renegotiating Britain’s relationship with the European Union as well as the impact of the refugee crisis.

Our last article, by Rumki Majumdar, looks at how emerging markets are likely to be affected by the change in US monetary policy. She examines the past experience of emerging-market responses to shifts in advanced-market financial conditions in order to infer what might happen next. She offers insights into the possible path of exchange rates, interest rates, and equity prices. Moreover, she notes that the likely outcome will be driven not only by US monetary policy but also by factors such as oil prices, China’s slowdown, and major market exchange rates. She concludes that the key to resilience for emerging markets lies in structural reforms that provide confidence to investors.